1. LOG 408: Global Logistics Management
Lecture 3: Outsourcing and Procurement

2. Key Points of Last Lesson
Rapid growth of international trade in recent decades
Measuring logistics performance of countries (LPI & LSCI)
What is globalization, is it good or not?
The positions of countries in globalization, as well as its drivers
The role of multinational companies in global trade, and the impact of their overseas investments
Directional imbalances in freight volumes and solutions

3. Trends in the manufacturing sector due to globalization
Global competition
Global sourcing
Global value chains resulting in increasing complexity and competition
Global access to knowledge and new technologies
SCM expertise and innovation play more roles for business success

4. Outsourcing
The transfer of to a third party of the management & delivery of a process previously performed by the company itself
It can happen within same country
Offshore outsourcing: Outsourcing to firms in faraway countries, often lower cost locations
Most prominent outsourcing locations: China (manufacturing) and India (service)
e.g., Volvo Trucks (India)

5. Some observations on outsourcing
Outsourcing components have increased progressively over the years
Some industries have been outsourcing for an extended time
Fashion Industry (e.g., Nike) (all manufacturing outsourced)
Firms outsource to reduce cost, not only manufacturing, inventory, and transportation cost, but also capital costs
Electronics Industry
Cisco (major suppliers across the world)
Apple (over 70% of components outsourced)

6. Supplier Footprint Supply Strategies have changed over the years
American automotive manufacturers
1980s: Suppliers either in the US or in Germany.
1990s: Suppliers in Mexico, Spain, and Portugal.
2000s: Suppliers in China
High-tech industry
1980s: Sourcing in the US
1990s: Singapore and Malaysia
2000s: Taiwan and mainland China
Challenge:
Strategy should depend on the type of product or component purchased

7. It Covers not just Manufacturing but Product Design, Too…
Taiwanese companies now design and manufacture most laptop sold around the world (e.g., Quanta, Compal)
Brands such as Hewlett-Packard and PalmOne collaborate with Asian suppliers on the design of their PDAs.

8. Questions/Issues with Outsourcing
Why do many technology companies outsource manufacturing, and even innovation, to Asian manufacturers?
What are the risks involved?
Should outsourcing strategies depend on product characteristics, such as product clockspeed, and if so how?
What should be considered in the buy /make decision process?

9. Discussion
Watch a Video on outsourcing and discuss author’s proposition: Outsourcing is bad for business (
The author’s reasoning:
Cost
Risk
Core competency
Are they valid?

10. Outsourcing Benefits (1)
Economies of scale & risk pooling
Aggregation of multiple orders reduces costs, both in purchasing and in manufacturing
e.g., Dell outsources design and production of processors in its PCs to Intel. Intel supplies many computer manufacturers and gains economies of scale that are not available to Dell if it designs and produces its own processors.
Demand uncertainty transferred to the suppliers
Suppliers reduce uncertainty through the risk-pooling effect
Reduce capital investment
Suppliers’ higher investment shared among customers.

11. Outsourcing Benefits (2)
Focus on core competency
Buyer can focus on its core strength
Allows buyer to differentiate from its competitors
Increased flexibility
The ability to better react to changes in customer demand
The ability to use the supplier’s technical knowledge to accelerate product development cycle time
The ability to gain access to new technologies and innovation.
Critical in certain industries:
High tech where technologies change very frequently
Fashion where products have a short life cycle

12. Outsourcing Risks Underestimating the cost/effort of coordination.
Reduced customer/supplier contact.
e.g., Boise Cascade outsourced all its outbound distribution to 3rd parties and lost considerable contact with its customer base. Solution: BC in-sourced distribution in the local area while letting much of its distribution be handled by 3rd parties.
Loss of internal capability and growth of 3rd party power.
e.g., computer industry in the mid 1980’s.
Conflicting objectives between suppliers and buyers
Leakage of sensitive data and information.

13. Example of Outsourcing Problems
IBM in PC industry
market entry in 1981
Outsourced many components to obtain market quickly
40% market share by 1985 beating Apple as the top PC manufacturer
Other competitors like Compaq used the same suppliers
IBM tried to regain market by introducing the PS/2 line with the OS/2 system
Suppliers and competitors did not follow
IBM market share shrunk to 8% in 1995
Behind Compaq’s 10% leading share
Led to eventual sale of PC business to Lenovo

14. A Framework for Make/Buy Decisions
How can the firm decide on which component to manufacture and which to outsource?
Focus on core competencies
How can the firm identify what is in the core?
What is outside the core?
The Fine/Whitney framework. Reasons for outsourcing:
Dependency on capacity – has the knowledge but decides to outsource
Dependency on knowledge – doesn’t have the knowledge (people or skills) to produce the product

15. Outsourcing Decisions at Toyota
About 30% of components in-sourced
Engines:
Company has knowledge and capacity, all are produced internally
Transmissions
Company has the knowledge, designs all components, but depends on its suppliers’ capacities, 70% outsourced
Vehicle electronic systems
Designed and produced by Toyota’s suppliers, it has dependency on both capacity and knowledge
Toyota varies its outsourcing practice by the strategic role of the components and subsystems
The more strategically important the component, the smaller its dependency on knowledge or capacity of suppliers.

16. Product architecture – integral and modular products
Components are independent of each other
Components are interchangeable
Standard interfaces are used
A component can be designed or upgraded without regard to other components
Customer preference determines the product configuration
Integral products
Not made from off the shelf components
Designed as a system (top-down design approach)
Evaluated based on system, rather than component, performance
Components perform multiple functions

17. A Framework for Make/Buy Decisions based on internal ability
Product
Dependency on knowledge and capacity
Independent for knowledge, dependent for capacity
Independent for knowledge and capacity
Modular
Outsourcing is risky
Outsourcing is an opportunity
Opportunity to reduce cost through outsourcing
Integral
Outsourcing is very risky
Outsourcing is an option
Keep production internal
3-17

18. More external factors to consider on the make /buy decision
Important criteria:
Importance of the component to the customer.
Component clockspeed.
Competitive position.
Capable supplier base.
Architecture.
For example, component is important to the customer, clockspeed is fast, firm has competitive advantage => keep manufacturing in-house, independent of number of suppliers and the component architecture

19. Examples of Decisions Criteria Example 1 Example 2 Example 3 Example 4
Customer Importance
Important
Not important
Clockspeed
High
Slow
Competitive Position
Competitive Advantage
No advantage
Capable Suppliers X
Key variable to decide strategy
Architecture
DECISION
Inhouse
Outsource
Inhouse,
Acquire suppliers,
Partnership
Outsource with modular, Inhouse or joint development with integral
3-19

20. Overview of Sourcing Decision
In-house or outsource?
If outsourcing, then select the suppliers. How many and who? What is process and criteria for selection?
Procurement – the process in which the supplier sends product in response to customer orders.

21. Criteria for evaluating and selecting outsourcees
Minimum requirements:
Reliability of delivery on time
Quality certifications
Conformance to agreed specifications
Delivery lead time
Financial capability
Performance track record
Price or cost reduction
Senior management attitude
Responsiveness to demand uncertainty
Record of corporate social responsibility

22. Procurement Strategies
Impact of procurement on business performance
2005 profit margins for Pfizer (24%), Dell (5%), Boeing (2.8%).
Reducing procurement cost by exactly 1% of revenue would have translated directly into bottom line, i.e., net profit.
To achieve the same impact on net profit through higher sales
Pfizer would need to increase its revenue by 4.17 (0.01/0.24) %
Dell by 20% and Boeing by 35.7%
The smaller the profit margins, the more important it is to focus on reducing procurement costs.

23. Fisher’s functional vs. innovative products

24. Functional and Innovative Products
Functional Products
Diapers, soup, milk, tiers
Focus: efficiency, cost reduction, and supply chain planning.
Innovative products
Fashion items, cosmetics, or high tech products
Focus: high profit margins, fast clockspeed, and unpredictable demand, responsiveness, maximizing service level, order fulfillment

25. Procurement Strategy Functional Products
Focus should be on minimizing total landed cost
unit cost
transportation cost
inventory holding cost
handling cost
duties and taxation
cost of financing
Sourcing from low-cost countries, e.g., mainland China and Taiwan is appropriate
Innovative Products
Focus should be on reducing lead times and on supply flexibility.
Sourcing close to the market area
Short lead time may be achieved using air shipments

26. Questions to think
What are the most frequently reported problems in outsourcing? How would you argue with the youtube video on “outsourcing is bad”?
Discuss the appropriate sourcing strategy for a component with low customer importance, fast clockspeed, and no competitive advantage. Should it be made in-house or outsourced?